Crypto's Long-Term Investment Potential: Worth The Risk?

Cryptocurrency has become increasingly popular since the launch of Bitcoin in 2009, the first and most popular cryptocurrency. The total value of cryptocurrencies is now about $1.7 trillion, with Bitcoin accounting for over $800 billion. This rapid appreciation has led many investors to question the place of stocks in their portfolios. However, there are significant differences between stocks and cryptocurrencies, and it is important to understand the risks and rewards of each before investing.

Stocks are fractional ownership interests in a business, giving shareholders a claim on the assets and cash flow of the company. In contrast, cryptocurrencies are typically not backed by hard assets or cash flow, and their value is driven solely by speculation and sentiment. While stocks have a long history of producing solid investment returns, cryptocurrencies are highly volatile and can be extremely risky.

Despite the risks, some investors view cryptocurrency as a potential hedge against fiat currencies and inflation. Additionally, the growing interest in cryptocurrencies from investors, companies, and governments could lead to wider adoption and increased value. However, it is important to note that cryptocurrency is not subject to the same regulatory oversight and investor protections as stocks.

When considering whether to invest in cryptocurrency or stocks, it is essential to weigh the risks and rewards and determine how well each fits your investment goals and risk tolerance. Given the inherent risks of cryptocurrency, it is generally recommended to allocate only a small portion of your portfolio to this asset class.

Crypto's volatility

Crypto is widely considered to be a volatile asset, with the potential for significant upward and downward movements over short periods. Volatility refers to the rate at which the price of an asset increases or decreases for a set of returns. The more volatile an asset is, the riskier it is considered to be as an investment, and the more potential it has to offer higher returns or higher losses over shorter periods than less volatile assets.

As a relatively new asset class, crypto is more volatile than stocks, with frequent and significant price swings. Crypto markets are still in their infancy, and the asset class is considered an outlier compared to traditional assets like stocks or commodities. The market is still finding its feet, and investors are still trying to establish a consensus on the fair value of digital assets.

The small size of the crypto market also contributes to its volatility. The total crypto market cap is a fraction of the size of the US stock market, and liquidity is fractured across many different exchanges and trading venues. This makes it difficult for large players to enter or exit the market without affecting prices.

The distribution between supply and demand also plays a role in crypto volatility. The limited supply of certain assets, such as Bitcoin, can create conditions where sudden increased demand puts upward pressure on prices, increasing volatility. Large holders, often called "whales," can also significantly impact prices by buying or selling large quantities of a particular asset.

Crypto markets are also heavily influenced by investor sentiment. The immaturity of the market means that positive or negative views can spread like a contagion, and investors are typically individual/retail investors who are less informed and more impressionable than traditional investors.

While crypto is a volatile asset, it is possible to mitigate some of the risks associated with investing in it. Diversification through cryptocurrency ETFs can reduce direct investment risks. Additionally, the increasing pace of crypto adoption suggests a maturing industry and safer investments. Some cryptocurrencies, such as stablecoins, are specifically designed to have low volatility.

Regulatory risks

In the United States, for example, federal agencies have taken different approaches to defining and regulating cryptocurrencies. The US Treasury views Bitcoin as a virtual decentralized currency but not as legal tender, while the Internal Revenue Service has defined it as property subject to capital gains tax. The Commodity Futures Trading Commission considers Bitcoin a commodity, and the Securities and Exchange Commission (SEC) has ruled that Bitcoin assets or tokens can be defined as securities subject to its authority.

The SEC, in particular, has been skeptical of cryptocurrency and has taken enforcement actions against players in the industry. SEC Chair Gary Gensler has stated that crypto companies need to "come into compliance" with existing laws and has expressed hopes that the SEC might offer consumers protection in areas such as crypto lending. The possibility of new laws and regulations, as well as the application of existing ones, could significantly impact how crypto exchanges and companies operate and the level of risk for investors.

The regulatory landscape is also evolving globally. The International Monetary Fund (IMF), for instance, has issued reports calling for stronger financial regulation and supervision of the crypto ecosystem, as well as the development of global standards. The IMF specifically recommends that crypto asset service providers be licensed, registered, and authorized, with clear rules governing their operations. They also suggest that stablecoin issuers be subject to strict prudential requirements to maintain monetary and financial stability.

The lack of consistent and comprehensive global regulation is a significant concern, as the cross-sector and cross-border nature of crypto limits the effectiveness of uncoordinated national approaches. As the crypto market continues to grow and deepen its links with the traditional financial system, regulatory action will likely increase to address risks to market integrity, user protection, and financial stability.

The regulatory risks in the crypto space are heightened by the fact that crypto exchanges and ATMs do not always fit neatly into existing regulatory frameworks. For example, crypto exchanges are now considered money service businesses (MSBs) under the Anti-Money Laundering Act of 2020 (AMLA 2020) in the US, but they also have similarities to financial institutions. This blurring of categories can create challenges for regulatory compliance and enforcement.

Additionally, the anonymous nature of crypto transactions, the lack of regulatory oversight in some jurisdictions, and the limited understanding of crypto among financial compliance professionals contribute to the risk of illicit activities, such as money laundering, fraud, and the funding of illegal activities.

To mitigate these risks, regulatory authorities will need to take a more proactive approach to overseeing the crypto industry, and companies operating in this space will need to ensure they are compliant with evolving regulations. However, until there is a more comprehensive and globally consistent regulatory framework for crypto, investors will continue to face regulatory risks that could impact their investments.

Security concerns

The decentralised nature of cryptocurrencies means that there is no body or administrator overseeing the creation, movement, and management of the currency. This lack of regulation and user control, combined with the digital nature of the currency, makes cryptocurrencies susceptible to several security concerns.

Phishing

Phishing is a method employed by hackers to mimic a trustworthy company and send emails to subscribers to convince them to take a specific action, such as clicking on a harmful website or providing their login information. The goal of phishing scams is to trick cryptocurrency users into giving away their digital assets.

Unregulated and Hackable Cryptocurrency Exchanges

Cryptocurrency exchanges, where digital money is bought and traded, are regulated inconsistently, and there is no requirement for security audits, assessments, or controls. This makes them vulnerable to hacking and other criminal activities. For example, in one incident, hackers stole more than $550 million worth of crypto from Coincheck.

Cyber Attacks

The blockchain's history can be changed by attackers who set up numerous false identities or nodes to take over the network. Additionally, perpetrators can flood the blockchain network with traffic, blocking the processing of valid transactions.

Fraud

As with any unregulated industry, fraud is prevalent in the cryptosphere. Cryptocurrency fraud soared in 2022, and the lack of regulatory oversight left many thousands of investors out of pocket.

Loss of Capital

With Bitcoin down more than 60% over the past 12 months, investors could easily lose a significant part of their original investment.

Private Key Security

Any digital currency is accessed via a private "key", which is a complex password code. If this key is stored on a computer, it is vulnerable to hackers, and if it is lost, the investment is lost permanently.

Blockchain's potential

Blockchain technology has far-reaching applications across many industries. It has the potential to be used in conjunction with emerging technologies and its applications are still being discovered. Here are some areas where blockchain technology could be valuable:

Cross-Border Payments

Blockchain has the potential to revolutionise cross-border payments by providing a much faster and cheaper alternative to traditional methods. While typical money remittance costs can be as high as 20% of the transfer amount, blockchain may allow for costs to be just a fraction of that, with guaranteed and real-time transaction processing speeds. This could be a game-changer for international businesses and individuals sending money abroad.

Smart Contracts

Smart contracts are self-executing contracts that can be programmed to automatically carry out the actions specified in the contract when certain conditions are met. They provide a more secure and automated alternative to relying on another party to fulfil their contractual obligations. The potential applications of smart contract technology are essentially limitless and could extend to almost any field of business where contract law applies.

Identity Management

Blockchain technology can be used to transform the way online identity management takes place, offering a high level of security through independent verification processes. This could be applied to maintaining voter information, ensuring the proper functioning of the electoral process, and securely transferring user data across platforms and systems. Blockchain could also be used to maintain and protect real estate ownership records, titles, and other important documents.

Supply Chain Analysis

A well-functioning and efficient supply chain is crucial for the success of many businesses. Blockchain technology has already been used in multiple industries to keep track of supply chains and ensure their efficiency, eliminating human error in a complex and critical process.

Healthcare

Blockchain technology can be used to protect and secure sensitive patient data, as well as facilitate data sharing between healthcare providers and researchers. This could improve patient care and outcomes, as well as enable new medical research and innovations.

Banking and Finance

Blockchain technology could revolutionise banking and finance by providing a secure and transparent way to store and transfer financial data, process transactions, and prevent fraud. It also has the potential to disrupt traditional lending and investment industries by providing new, decentralised options for borrowing, lending, and investing.

While blockchain technology offers many potential benefits, it is not without its risks and challenges. These include regulatory hurdles, security concerns, and the environmental impact of the energy-intensive processes required to maintain a blockchain. However, as blockchain technology continues to evolve and new use cases emerge, it has the potential to transform numerous industries and society as a whole.

Long-term investment strategies

Cryptocurrency is a risky investment due to its volatility and the numerous risks involved, such as wallet hacking, cybersecurity threats, and regulatory uncertainties. However, it can be a good long-term investment option if you do it properly and as part of a diversified portfolio. Here are some things to keep in mind if you're considering investing in cryptocurrencies for the long term:

• Understand the risks: Cryptocurrency values can fluctuate drastically, and there is a potential for significant financial loss if you sell at the wrong time. Other risks include fraud, cybercrime, and future regulation.
• Do your research: Understand what you are investing in. Learn about the technology, adoption, regulation, and market demand for the specific cryptocurrency you are considering. Make sure you have an investment thesis for each cryptocurrency you invest in.
• Have a high-risk tolerance: Investing in cryptocurrencies requires a high-risk tolerance as there are no guarantees that the market won't collapse. Consider what would happen if you lost all your investment.
• Diversify your portfolio: Invest in a small but diversified group of coins to build personal wealth over the long term. This will help reduce your risk if one coin plummets in value.
• Have a long-term perspective: Cryptocurrencies are highly volatile, and prices can fall and rise dramatically. Hold your investments for the long term to attain the best return on investment.
• Choose established cryptocurrencies: Some good options for long-term investment include Bitcoin, Ethereum, Cardano, Polkadot, and Chainlink. These cryptocurrencies have a larger market cap, better brand recognition, and more real-world applications, making them safer options.
• Consider the benefits of blockchain technology: Blockchain technology provides security and transparency to transactions, making it a great payment tool for long-term crypto investments. Smart contracts, in particular, add an extra layer of protection and are driving market capitalization and long-term growth in the crypto space.
• Be cautious: Cryptocurrency is a speculative investment, and it's important to approach it with caution. Only invest money you can afford to lose, and make sure it aligns with your risk tolerance and financial goals.
• Understand the tax implications: In many countries, cryptocurrencies are taxed as property, and any transactions, including mining or staking, may trigger a tax liability. Consult with a tax advisor to understand the specific rules in your country.

Frequently asked questions